2018 Report Card For Hedge Funds

Hedge funds entered 2019 coming off their ninth-straight year of trailing U.S. stocks (as measured by the S&P 500 Index) by significant margins.

And for the 10-year period ending 2017 — one that included the worst bear market in the post-Depression era — the HFRX Global Hedge Fund Index produced a negative return (-0.4%), underperforming every single major equity and bond asset class.

So how did hedge funds fare in 2018? The following table shows the returns for various equity and fixed-income indexes. The HFRX Global Hedge Fund Index returned -6.7%.

Through
December 2018 (%)

HFRX Global Hedge Fund Index

-6.7

Domestic Indexes

S&P 500

-4.4

MSCI US Small Cap 1750 (gross dividends)

-11.0

MSCI US Prime Market Value (gross dividends)

-7.4

MSCI US Small Cap Value (gross dividends)

-12.9

Dow Jones Select REIT

-4.2

International Indexes

MSCI EAFE (net dividends)

-13.8

MSCI EAFE Small Cap (net dividends)

-17.9

MSCI EAFE Small Value (net dividends)

-18.2

MSCI EAFE Value (net dividends)

-14.8

MSCI Emerging Markets (net dividends)

-14.6

Fixed Income

Merrill Lynch One-Year Treasury Note

1.9

Five-Year Treasury Notes

1.2

20-Year Treasury Bonds

-0.6

As you can see, the hedge fund index outperformed eight equity asset classes, but underperformed all fixed-income indexes. We can take our analysis a step further and determine how hedge funds performed against a globally diversified portfolio.

Key Comparisons

An all-equity portfolio allocated 50% internationally and 50% domestically, equally weighted among the indexes from the table within those broader categories, would have lost 11.9% over the year, underperforming the hedge fund index by 5.2%.

Another comparison we can make is to a typical balanced portfolio of 60% equities and 40% bonds. Using the same weighting methodology as above for the equity allocation, the portfolio would have lost 6.4% using one-year Treasuries (outperforming the hedge fund index by 0.03%), lost 6.7% using five-year Treasuries (performing in line with the hedge fund index), and lost 7.4% using long-term Treasuries (underperforming the hedge fund index by 0.70%).

As mentioned earlier, hedge funds outperformed most equity asset classes we reviewed in 2018. However, they performed roughly in line with a 60/40 portfolio with five-year Treasuries. Thus, in a down market, hedge funds didn’t offer any protection compared to a standard diversified portfolio.

If we look back over the 10-year period ending December 2018, the HFRX index earned 1.5% per year on average, compared with 10.2% per year for the equal-weighted equity index and 6.9% for the same 60/40 portfolio with five-year Treasuries. Five-year Treasuries earned 2% per year. Here’s the full breakdown of each asset class over the 10 years:

10 Years Through
December 2018 (%)

HFRX Global Hedge Fund Index

1.5

Domestic Indexes

S&P 500

13.1

MSCI US Small Cap 1750 (gross dividends)

13.3

MSCI US Prime Market Value (gross dividends)

11.4

MSCI US Small Cap Value (gross dividends)

11.9

Dow Jones Select REIT

12.0

International Indexes

MSCI EAFE (net dividends)

6.3

MSCI EAFE Small Cap (net dividends)

10.5

MSCI EAFE Small Value (net dividends)

10.1

MSCI EAFE Value (net dividends)

5.5

MSCI Emerging Markets (net dividends)

8.0

Fixed Income

Merrill Lynch One-Year Treasury Note

0.6

Five-Year Treasury Notes

2.0

20-Year Treasury Bonds

3.7

Market Efficiency The Foe

Despite attracting some of the brightest minds in finance, hedge funds continue to struggle to outperform broader market indexes. The problem is that the efficiency of the market, as well as the cost of the effort, can turn a supposed advantage into a handicap. Given the evidence on hedge funds’ underwhelming results, it’s a puzzle why they are still managing about $3 trillion in assets.

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The opinions expressed by featured authors are their own and may not accurately reflect those of the BAM ALLIANCE®. This article is for general information only and is not intended to serve as specific financial, accounting or tax advice.

Larry Swedroe

Director of Research

Larry Swedroe is director of research for Buckingham Strategic Wealth, Loring Ward, and the BAM ALLIANCE.
Previously, Larry was vice chairman of Prudential Home Mortgage. Larry holds an MBA in finance and investment from NYU, and a bachelor’s degree in finance from Baruch College.
To help inform investors about the evidence-based investing approach, he was among the first authors to publish a book that explained evidence-based investing in layman’s terms — The Only Guide to a Winning Investment Strategy You’ll Ever Need.